Surplus Transfer: Windfall For Government, Balancing Act For RBI

The Reserve Bank of India’s latest transfer of a record surplus to the central government for 2024-25 has sparked intense debate—ranging from good to bad. Over the years, significant surplus transfers by the RBI have helped the government manage its fiscal deficit and borrowings more effectively. 

However, what makes these massive transfers noteworthy is not just their magnitude but the complex mix of macroeconomic, monetary, and institutional dynamics that underpin them. The story is not merely about large surpluses but about how a central bank must constantly balance its operational independence, policy objectives, accountability to the government and the public and, last but not the least, the political economy compulsions.

While surplus transfers are not new, their size and source highlight the unique nature of central bank income. Unlike commercial banks, and for that matter any company, which pursue profit maximisation, central banks operate within mandates defined by law, typically centred around monetary stability, inflation targeting, financial system resilience, and currency management. Profitability, though a by-product of these functions, is not an objective—ideally. In other words, policy efficacy takes precedence over efficiency with which resources are deployed. 

Central banks earn revenue through several unique channels, primarily rooted in their monopoly privileges. The issuance of currency—essentially a zero-cost liability—generates seigniorage income when deployed into interest-bearing assets like government securities. Additionally, commercial banks maintain reserves with the central bank, often unremunerated or remunerated at sub-market rates, allowing the RBI to profitably reinvest those funds.

Foreign exchange reserve management and liquidity operations represent another major source of income. In India’s case, large holdings of US Treasuries and other safe assets, combined with active forex intervention, create earnings opportunities, especially when valuation movements are favourable.

However, this income is inherently volatile. Exchange rate and interest rate fluctuations lead to valuation changes that may not reflect realised gains. What further complicates the legitimacy of such central bank operations is the fact that these fluctuations can themselves be influenced by its own policies. 

Realised Vs Unrealised Profits
A key debate in central banking surrounds the distribution of realised versus unrealised profits. Realised profits represent an actual transfer of resources from the economy to the central bank—effectively reducing the monetary base. When such profits are transferred to the government, it constitutes a neutral transaction from a monetary standpoint.

Unrealised profits, however, are a different matter. Distributing such gains injects liquidity into the system without a corresponding absorption, effectively loosening monetary conditions. This can undermine the central bank’s policy stance, particularly if inflation control or monetary tightening is underway. In essence, distributing unrealised gains is akin to unsterilised monetisation of government spending—a practice that contradicts modern central banking principles and is prohibited in many legal frameworks.

The question of how much capital a central bank should maintain is far from settled. Unlike commercial banks, where capital adequacy is tightly regulated and standardised, central bank capital levels are shaped by broader considerations: economic stability, exposure to financial system risks, currency volatility, inflation trends, and systemic shocks.

Maintaining adequate capital is essential for policy credibility. A well-capitalised central bank can undertake emergency liquidity operations, absorb losses from forex interventions, and maintain market confidence. But excessive capital—far above what is needed for operational stability—carries an opportunity cost for the government. It locks up fiscal resources and reduces the funds available for public investment or deficit financing.

This delicate balance often becomes a source of friction between central banks and governments. While governments seek higher transfers to support spending, central banks are duty-bound to maintain buffers to preserve independence and avoid future recapitalisation needs that could compromise credibility.

Examples abound globally. In some jurisdictions, central banks have built excessively large buffers, drawing criticism for being fiscally inefficient. Conversely, low-capital levels have forced central banks to rely on government support, undermining their autonomy.

Reporting Standards
Historically, central bank financial statements were brief and opaque, with limited disclosures. The rationale was straightforward: excessive transparency might impair policy effectiveness or reveal sensitive operations. Many central banks used conservative accounting practices, allowing the creation of hidden reserves to absorb shocks.

The post-crisis era, however, has ushered in a demand for greater accountability and transparency. Many central banks now follow International Financial Reporting Standards or local equivalents, bringing their statements closer to those of commercial institutions. This shift, while limiting discretionary provisioning, enhances public trust and reinforces the institutional legitimacy of central banks. The European Central Bank, for instance, remains an outlier, with its own accounting framework under the European System of Central Banks. Even here, the divergence is narrow—primarily in the deferral of unrealised valuation gains.

While governments, as owners, can legitimately ‘demand’ surpluses generated by their respective central banks, the problem arises when they ‘decide’ how much surpluses they should be getting much ahead of central bank operations which are contingent upon the evolving macroeconomic situation. In India’s case, the government proposes in its annual budget at the beginning of the year, if not directly but subtly, the size of such surplus transfers from the central bank which, it may be argued, becomes a mandate for the central bank how much profits it has to generate during the year.  

Consider the RBI’s forex operations interventions. In 2024-25, the RBI undertook gross sales of $399 billion, compared to $153 billion in the previous year. Even on a net basis, it sold $34.5 billion, less than a tenth of its gross sales. Now going back to the realised versus unrealised gains debate, such large gross sales, often achieved through sell-buy swaps, with a low volume of net sales, generate substantial “realised” profits given that the historical cost of the dollars acquired is much lesser than the current spot rate. Swaps could alternatively be accounted based on the price differential; instead they are accounted as outright sales and purchases, which also increases the holding cost of dollars while reducing the buffer for future profits. Such operations may create the impression that the objective of “efficiency of resources utilised” overtakes “efficacy of policy necessitated”.

The huge surplus transfer from the RBI is more than just a fiscal windfall; it appears as a case of market operations and policy alignment co-existing. What if the government becomes dependent on larger surplus transfers from the central bank, and the central bank is conditioned to oblige. There are legitimate arguments that as the economy becomes more integrated globally and susceptible to shocks, the need for a strong and autonomous central bank becomes even more critical. Some would argue that the US policies to undermine the strength of the dollar could have really come to the RBI’s rescue this time, especially in the case of non-deliverable forward dollar sale operations. The balance between supporting fiscal needs and preserving policy credibility will remain an enduring theme in central bank-government relations.

The RBI’s cautious approach in 2024-25—setting aside a larger chunk of its profits into the Contingency Risk Buffer—reflects an awareness of these risks. By doing so, it ensures policy consistency and strengthens its financial resilience against future shocks.

In a year of uncertain revenues and rising geopolitical risks, the RBI’s record surplus transfer is a stabilising force for India’s fiscal landscape. With the benefit of hindsight, one might argue that it reflects effective reserve management, prudent liquidity operations, and a sound economic capital framework. But beyond the numbers, it highlights the evolving role of modern central banks: institutions that must generate returns not for profit, but for stability—guardians of the economy that walk the tightrope between independence and accountability.